Real QE is yet to come in Europe

I wrote here last week that the key question about the ECB’s monetary easing was not so much what assets the ECB intended to buy, but who it intended to buy those assets from.

This is key for a very simple reason. If a central bank buys assets (whatever they are – sovereign bonds, mortgages, etc) and the banking system is broken, it will make no difference whatsoever to the wider economy. For that to happen, the money needs to be lent out – and broke banks don’t make loans. The policy transmission mechanism doesn’t work.

If, however, the central bank goes into the market and buys the assets freely there, it direct injects new money into those markets – money that then gets passed around.

This is why QE had no effect in Japan, beyond preventing the obvious bankruptcy of the banking system in the 1990s but appears to be having an effect now (in the past the Bank of Japan bought from the banks, now it is buying in the market).

So which is it this time around in Europe?

When I read the ECB’s statement, it looked very much as though the plan was to buy from the banks, largely because the market in asset backed securities (ABS) isn’t big enough for anything else to happen.

However, MoneyWeek regular James Ferguson, of Macro Strategy Partners, is more of an expert on the inside workings of central banks than I will ever be, so I asked him to take a look too. He has. And he agrees with me.  

It appears that new ABS are “to be created for the purpose directly from banks’ loan books”. This is nice for the banks – it helps them deleverage. But it doesn’t inject new money, and it doesn’t do much for credit easing. Real QE is yet to come in Europe.